Employment law 'is having a negative effect' on firms

Friday, 24 April, 2009, 12:00am

Kate Watson

The mainland's employment law may have exacerbated the effects of the global financial crisis.

Anecdotal evidence collected by accounting firm Grant Thornton suggests that many of the 16,000-plus small and medium-sized operations that closed down in the Pearl River Delta between March last year and last month did so because of increased costs as a result of the new law, which came into effect on January 1 last year.

'While the basis of the new law was to standardise employees' entitlements, the legislation appears to have had a negative effect on some companies,' said Alan Tang, partner and head of restructuring at Grant Thornton Hong Kong.

'Many were operating on a basis that was quite different from [the one] that [was] required by the new employment law.

'To implement changes almost overnight brought about a lot of financial pressure on companies, owners and shareholders, which contributed to their difficulties.'

In seeking to protect labour rights and prevent the exploitation of migrant workers, the new law applies standards similar to those of the International Labour Organisation and principles generally applied or incorporated by European Union legislation.

It enshrines in law the entitlements of employees in mainland-based companies, whether domestic or foreign-owned, and is intended to protect employees.

But it is also having a direct effect through the operation of the mainland's bankruptcy law, which came into effect in June 2007 and deals with employees as creditors.

The problem is that there is no clear interface between the employment law and the bankruptcy law.

While the provisions under the bankruptcy law were clear about the entitlements of employees, there were several grey areas under the employment law for which clarification by supplementary working rules or explanatory notes from the Supreme People's Court would be welcomed by accountants, Mr Tang said.

'For example, the employment law doesn't specify the entitlements of employees in an insolvent situation, whether that is a restructuring or bankruptcy,' he said.

In some ways, the nuances of the laws are academic. The vast majority of small and medium-sized operations that closed recently in the Pearl River Delta, for example, did not file for bankruptcy.

'Many didn't even have the funds to pay employees, so the larger creditors didn't bother to file a formal petition to the local court because they knew there was no money there,' Mr Tang said.

In a few larger cases, with companies employing 2,000-plus workers, creditors have petitioned the courts to file a formal bankruptcy petition but the courts have proved hesitant to act.

Once a bankruptcy petition is filed and the process of auctioning off equipment starts, the return to the creditors and employees is often minimal because the plant machinery and equipment have only scrap value.

This had led to situations where local governments, courts and major creditors having to maintain the status quo by trying to find a buyer and carry out restructuring outside the bankruptcy law.

According to Derek Lai, reorganisation services partner at Deloitte China, the mindset of court judges and others involved in potential bankruptcy cases needs to change.

'Holding up bankruptcy proceedings doesn't help the situation because it means some creditors cannot get money back; this doesn't help,' he said.

'At least with the restructuring provision under the bankruptcy procedures, a company can restructure under the bankruptcy law, the creditors know what's going on and they can prepare for it.'